When it pays to consolidate your debt

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When it pays to consolidate your debt
Debt consolidation, if done properly, can allow you to simplify your bookkeeping system and to potentially pay off your loans at an overall lower interest rate. But it sometimes requires offering items you own as collateral in case you can't pay it off and can lead to pushing you even further into debt.

There are two types of debt consolidation offers. The first comes from a finance company, which will offer to loan you the money to pay off your bills and owe just one creditor -- them. The problem here is that finance companies charge sky-high interest rates. That means the finance company has an incentive to stretch out your payments to increase the interest. Worse yet, many creditors consider finance companies the lender of last resort. So you can actually damage your credit rating by using a finance company even if you're paying on time.

The second type of debt consolidation loan is offered by a bill-paying service, which can be even more dangerous. These services charge you a fee -- perhaps 10% of your debt -- to pay your bills each month. They simply act as a bookkeeping service. Bill-paying services do not consolidate your debt. Some of them even neglect to pay your bills on time, says credit consultant Geri Deitweiler.

The credit card tease

Many credit-card issuers offer new cards with low initial teaser rates in the range of 5.9%, suggesting that you consolidate your debt and pay it off at that low rate. But Jane King, a financial planner in Boston who has evaluated these offers for a number of clients, says that, the fine print usually reveals additional rates and fees." Furthermore, the rate is a temporary one that doesn't last long enough to get the bills paid off.

Adding to your mortgage

So what can you do if you owe too much to too many creditors? The best option for consolidating debt is to roll it into your mortgage, King says. Because your home mortgage interest is tax deductible, you could borrow at an effective rate less than the stated interest rate. Let's say you're in the 28% tax bracket. That means you can deduct 28% of the interest paid on that loan at the end of the year.

"The debt attached to a residence is the only debt to have," King says.

You can do that by refinancing your home. Or you can take out a home equity line.

"If you don't want to marry up with 30 years of debt for either arithmetic or emotional reasons, look at the home equity line," King says. "

Credit counseling

Of course, many people who are head over heels in debt do not own a home or do not have enough equity to qualify for a loan. If you're in that situation, you may want to consider a credit adviser operation like the Consumer Credit Counseling Service.

Counselors in these offices, which are part of the National Foundation for Consumer Credit, a nonprofit organization set up to educate, counsel and promote the wise use of credit, help more than 1.5 million families each year. About one third of those who come in need a debt management program.

Credit counselors will help you with budgeting whether or not you are in trouble. Budget counseling is free in 80% of CCCS offices. The average cost to consumers who use these programs is about $10 a month.

If you and the counselor decide you need a debt management program, you must stop using your credit cards. The counselors will negotiate with your creditors for lower monthly payments and sometimes for lower interest rates. Those in the debt management program make one monthly payment to the credit counseling service, which distributes that money to creditors.

There are two caveats:

First, if you go through a debt management program and make less than minimum payments on your debt, it will show up on your credit report.

Second, credit issuers sponsor the service so the counselors have a bias toward helping you to pay off debt rather than filing for bankruptcy. If you really must file for bankruptcy to get a fresh start, you'll need to go elsewhere.

Still, the credit counseling service can be a great boon to those who feel panicky about their debt and unable to cope with the consequences. "One of the greatest benefits of this service is peace of mind," Deitweiler says. "It can help you get a good night's sleep and get back on track."

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